Observations From a Tipless Restaurant, Part 2: Money and the Law

This is part 2 of a series detailing what I learned from operating our farm-to-table flagship restaurant, the Linkery, as a “no-tipping” restaurant that instead charged a fixed percentage for service, from 2006 to 2013. We also operated a sister restaurant, El Take It Easy, that followed the traditional tipping model, allowing for a fairly direct comparison.

In order to understand how we ended up switching to a fixed service charge and declining tips, it’s helpful to understand some financial and legal facts about the restaurant industry that are not widely communicated to the public at large.

The first is that, for the most part, the restaurant industry operates on very slim margins. There are some restaurants that are very profitable, but the vast majority are not. I’ve read that the average profit for a restaurant is 4% of its revenue, and in my experience most independent restaurants do not have any real profit at all. More typically the owner is able to pay herself for her work, and that’s about it. This fact is important because it means that, for most jobs in the restaurant industry, the wage paid by the restaurant comes from a limited pool, and there is not a lot of flexibility in the size of the pool — if one job gets a $2/hour raise, that most likely means that another job will have its wage reduced by $2/hour.

Theoretically, it seems like there would be ways to free up more money for labor, and there are some methods that help. In the end, though, restaurant-going is so prevelant that the expectations of the market — for price, quality, ambience, and so forth — are pretty well set in every dimension. And the cost of meeting those expectations is pretty well set, too. So the business model for most restaurants, and what they pay for each job, is tightly constrained.

Now, let’s say that on a typical shift, a restaurant sells $1000 in food and drink. It would be reasonable that, to make that revenue, a restaurant has 2 cooks who work 8 hours each, a dishwasher who works 8 hours, and two servers who work 6 hours each. We can extrapolate from standard industry models that, of the $1000 in sales, there will be $300 available to cover the 36 hours of labor. It just so happens that this math means that everyone in the house will make $8/hour, which is of course both minimum wage and a poverty wage. But that’s just how the pie divides.

And yet, wait! We’ve forgotten something. There are also 220 extra dollars paid by the guests as tips. (This 22% is typical for restaurants like ours in San Diego — the exact amount will change with restaurant style and location.) This tip money could add another $6/hour to everyone’s wage, getting everyone up to $14/hr.  While $14/hr isn’t enough to live well in San Diego, it starts approaching realistic money.

However, to give the tip money to every worker would be illegal.  The law is historically very clear — the $220 in tips belongs to the two servers only, and cannot be distributed to any other employees. So, the two servers make a total of about $26/hour each, while everyone else in the restaurant is stuck at $8/hour.

Now, if you’re a server, you’re probably nodding your head that this seems fine! However, if you’re an owner or manager trying to operate an excellent restaurant, you’ve got some problems. From the perspective of the business, the cook and dishwasher are just as important to the guests’ experience as the server is. In fact, they may be even more important, particularly if your restaurant’s reputation is based on its food. But, now your cooks are making less than 1/3 of what the servers are making. The cooks’ wage is so low that talented cooks won’t be able to live on it, and they will probably leave the industry. Additionally, no matter what cooks you have, there will be a lot of ill will between the producers of the food, who are well below the poverty line, and the servers, who are making white-collar wages.

In some states (big East Coast restaurant states come to mind, like New York), the government balances this situation by offering what is called a “tip credit”. The tip credit allows restaurants to pay their front-of-house employees less than minimum wage (usually about $5/hr less), if tips will make up the difference. In the example above, the servers in a “tip credit” system would most likely end up making about $21/hour and, cooks about $12/hour, and the dishwasher still about $8/hour. To someone like me who puts a lot of demands on his kitchen, this distribution still feels inequitable — but it’s a lot closer to fair. While the “tip credit” is a blunt instrument, it does address the wage inequity problem enough to keep the tipping system at least somewhat viable.

Now, in California and several other states, the “tip credit” is not allowed, and the restauranteur has fewer options. The recourse most commonly used in these states is the “tipout”. Here the servers just give a portion of their tips to the kitchen, usually as part of a cultural expectation created within the restaurant. The problems with depending on a voluntary tipout to equal out the pay on the team are:

  1. Some servers may decide to withhold a tipout, in a sense cheating the system, and the employers is precluded from redressing this; and
  2. Servers may use that option of withholding their tipout, to extract special favors from the kitchen regardless of whether those favors hurt other guests or other servers.

In other words, with the business disallowed from enforcing the tipout system, control is left to the culture of the team in the restaurant; and humans being humans, more times than not that situation leads to hurt feelings, anger, or worse.

In a tipout system, what started as one enterprise (a restaurant selling its food & hospitality to its guests), has now spawned two completely new, concurrent businesses: the business of the server selling the perception of extra attention to the guest for tips; and the business of the kitchen workers selling favors to the servers for tipout.  These additional, parasitic businesses are not focused on improving the quality of the original enterprise. Instead, these secondary businesses are focused on maximizing income using short term, and proven effective, means.  (I won’t go into those means here, but you can find many of them detailed here.)

Over the last couple years, another alternative has started to emerge — the lawful tip pool.  In this model, the business is permitted by the law of the land to distribute its tips among every member of its team, including kitchen workers.  In the Ninth District (the western US), one court decision (Cumbie v. Woody Woo) has paved the way for this, but the US Department of Labor has attempted to nullify that decision by issuing new regulations.  It’s not clear that the Labor department is actually allowed to trump the court, and the matter is not yet clearly resolved. (Update: in February 2015, a ruling by a 3-judge panel of the Ninth Circuit made it once again clearly against federal law to include cooks in a tip pool).

Back in 2006, however, it was still definitely illegal for a tip pool to include back-of-house workers.  The only legal way that tip revenue could be distributed among the whole team was for it to not be tip revenue. Instead, it had to be an amount charged by the business for its service. In other words, a service charge.

So, following the lead of places like Chez Panisse, we added a line item service charge on our bills, and that allowed us to distribute the money paid for table service in a way that seemed more equitable.  Having more equitable distribution in money, of course, led to us having better quality service and food. In turn, we saw a sharp increase in business over the first two months of the new system.  Our servers’ total pay rose to about $22/hour, most of the cooks started making about $12-14 depending on experience, and the diswashers about $10. (Those numbers declined somewhat over the years, as the recession took its toll on restaurant check averages in San Diego).

There was big difference, however, between what we did and what places like Chez Panisse had done — unlike those other places, and unlike every other sit-down restaurant in America, we refused to accept money beyond the service charge.

We had a couple reasons for not letting our guests give extra money beyond the 18% we allocated for the cost of table service.  The first reason was that we wanted to make it clear to our guests that we were not trying to take more money from them — in fact, we were taking less, by switching from a tipped system that averaged 21-22% of the check, to a fixed 18%.  We were reducing our tip income by 15% as a show of good faith to our community.

The other reason we didn’t accept tips was that removing any option for tipping was the only way to remove those two parasitic businesses — the side business between the server and guest, and the side business between the server and cooks — from our own company.  By not allowing these side businesses to exist, we created an environment where all of us were engaged in only one mission, our stated goal of creating remarkable experiences for our guests, around local food and drink.  Being in only one business made us like pretty much every other company in America, except that it also made us unlike any other restaurant in America.

And the tension in that, of course, is where the interesting stuff was.

Click here to continue to Part 3.

Click here to read Part 1 of this series.